It’s natural to get surrounded by doubts, whenever you are making any type of investment. There is always a fair degree of uncertainty and risk associated with each and every investment. To make your investment successful, you have to have the skills of managing these risks. Three main types of risk, which are involved in any type of investment, are valuation risk, business risk and force of sale risk. These are as follow;
In the near past, I hit upon a company that was showing sharp growth. The company was increasing its penetration in the global market. Also, it was not even indebted. It become very difficult for me to purchase the shares of that company as its trade was much larger as compared to its average profits. In this scenario, a person, like me, develops a gut feeling that he could suffer severe financial loss, if at any times the company gets sudden losses. I would only purchase the stock shares, if I see some solid likelihood in the future increase of my revenues to an acceptable value. So, we can conclude the fact that we should pay due attention to the time at which we are investing, rather than concentrating on where we are investing. If we feel that it is feasible to invest at present time, then we should proceeded on immediately.
This type of risk includes the decrease in worth of a firm owing to incumbent competition, maladministration and potential bankruptcy. Industries like railways, airlines etc are really prone to this genre of risk.
Franchise value is the popularity of a particular brand in the market. A company having franchise value can easily take the bull by the horns and can survive difficult circumstances. Franchise value serves as a strong shield against business risk. The commodity-type businesses don’t have a franchise value and are subjected to significant business risks.
3- Force of sale risk:
If you analyse the stock market and discover a company that is selling its shares at very low price, you should consider yourself fortunate as you can buy these at no cost. After you have bought these shares, your biggest mistake would be to set a specified time limit before which you would not sell them. By doing such acts, you are cutting you own feet down. In the business of stock market, you can predict what will happen but you can’t say when it will happen. There are no hard and fast time limits as stock market is dependent on a number of inter-related factors. If you are planning to sell your shares at a particular instant of time, regardless of market trends, you are very much prone to liquidity risk. You may lose all of your investment at very negligible price. For example if you have purchased the shares of Coca-cola, Berkshire Hathaway etc in the last decade and you haven’t sold them before recession, you can estimate the amount of damage you may have to bear. In this case, your indefinite time limit proved lethal for you.
Each and every investment brings a certain amount of risk. Being an investor, you have to put efforts to minimize these risks. These risks, if left uncontrolled, can easily engulf all of your wealth.
Head on over to Investorz Blog, where Tony shares his market outlook and opinion on stocks, commodities, etc.